UK inflation drops slightly to 3 per cent

The Consumer Prices Index (CPI) stood at 3 per cent in December 2017, down from 3.1 per cent in November, according to the Office for National Statistics.

Once a month, the Office for National Statistics (ONS) determines the price of a ‘shopping basket’ of goods and services typically bought by UK households. This is used to calculate the consumer prices index measure of inflation.

In January last year, inflation stood at just 1.8 per cent, but it had risen to 3.1 per cent by November 2017. December marks the first slight easing in inflation since June last year, but it still exceeds the Bank of England’s target of 2 per cent.

The largest downward contribution came from transport, particularly air fares. The report states that as is usually the case in December, air fares rose sharply, but at a lower rate than in the previous year.

It’s important to understand that the ONS measures movements rather than price levels to guage inflation. In other words, if the cost of flights goes up by 10 per cent one year and it goes up by 8 per cent the next year, then the ONS will record this as a downward movement – but in real terms your plane ticket is still getting more expensive.

‘It remains too early to say whether today’s slight fall is the start of any longer-term reduction in the rate of inflation,’ cautions James Tucker, an ONS statistician.

Ben Brettell, senior economist at Hargreaves Lansdown, says: ‘Inflation has been a hot topic since the Brexit vote caused a sharp drop in sterling 18 months ago. But logic has always dictated that once the effect of the weaker pound percolated into the real economy, it should then start to drop out of the year-on-year calculations 12 months later.

‘It now seems likely we’ll see the rate steadily fall back towards the 2 per cent target over the next year or so.’

Brettell argues that if we strip out the Brexit noise, the UK’s underlying economic situation doesn’t look materially different from the rest of the developed world. ‘Big themes like an ageing demographic and the rise of disruptive technologies are exerting downward pressure on prices,’ he notes.

Ed Hutchings, senior portfolio manager for UK Sovereigns at Aviva Investors, agrees that inflation is likely to begin to fall again, and suggests this makes further significant interest rate hikes less likely. ‘With the remaining uncertainty surrounding Brexit negotiations, and wage gains still very much subdued, the Bank of England is likely to continue to proceed cautiously when raising interest rates further.’

With the market now pricing in two 0.25 per cent increases over the next two years, he argues, there are unlikely to be any large moves higher in the near term while Brexit uncertainty prevails.

Matthew Brittain, investment analyst at wealth manager Sanlam UK, says: ‘More worrying from our point of view is the continuing stagnation of wages, with increases tending to be well below the rate of inflation. This means that disposable incomes are in decline, forcing people to reduce their savings or take on more debt to maintain their standard of living.’

Maike Currie, investment director for Personal Investing at Fidelity International, echoes this concern: ‘While price pressures may have eased slightly, this will be cold comfort to cash-strapped consumers who are still suffering a pay cut in real terms as inflation continues to outpace wage growth (including bonus) at around 2.5 per cent.’

Persistently high inflation also holds implications for people’s savings, as inflation erodes the spending power of future interest payments and eats away at the worth of the original capital. Currie adds: ‘Physical assets such as gold, agriculture and property are all good protectors against the wealth-eroding effects of inflation.’

Thomas Wells, manager of the Smith & Williamson Global Inflation-Linked Bond fund, says: ‘While the overall profile for UK inflation looks better for 2018 than it did for 2017, there are some material tail risks that could result in sterling weakness, which would very easily re-ignite inflation concerns.’

For example, he points out the market ‘is not pricing in a general election this year despite the weakness of the May government, and there is no guarantee that the recent more positive tone of the Brexit negotiations will continue.’ If Brexit negotiations or May’s government take a turn for the worse, sterling would weaken, which would drive up import inflation once again.

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